Where is the value in tokens?

Crypto / blockchain has always been as much of a business model innovation as a technical innovation…

  • Technical innovation: running a decentralized ledger / platform at scale
  • Business model innovation: issuing tokens to give users / participants in the platform a stake in the project

By issuing crypto tokens, platforms gave early users an incentive to help bootstrap the service and solve the often inherent chicken and egg problem. These tokens act as value exchange / currency within a platform and often give owners specific rights like voting on forks, etc.

In the ICO bubble of 2017, nearly every crypto project introduced a token (often for fundraising purposes only). Yet very few ever answered why they actually needed a unique token for their project and how value would actually accrue to this token. Over the last few years, several concepts have evolved on how tokens can actually accrue value over time, with the underlying question always being if more people want to hold that specific token versus selling it (which means that the price should increase).

Store of value

The first and oldest idea around value accrual is centered around the store of value concept. If people think that a certain currency / token is a good store of value, that will drive demand in such token / currency. Bitcoin is the best example, but it’s also clear that very few tokens will have a shot at such a position (with ETH being probably first in line to join Bitcoin).

Working capital

The second concept is centered around the idea that I have to hold a token in order to participate in a platform or financial instrument and I have chosen to call it a working capital token. There have been two use cases that have evolved around working capital tokens.

The first use case is staking. Users on Numerai stake NMR tokens on their predictions as a way to express the confidence they have in their machine learning model. If their predictions are good, they earn money and their NMR is returned. If their predictions are poor, their NMR is destroyed. Users on the prediction market Augur stake the native token REP to create a bet, dispute a bet’s outcome and purchase participation tokens. For every action they take that uses REP, they are literally staking their reputation on it.

The second use case is using a token as a collateral in financial instruments, mostly in the Ethereum ecosystem. Decentralized finance platforms have recently gained in importance (especially Maker) and the amount of ETH locked up in these instruments is increasing significantly (see https://defipulse.com/).

I predict that both working capital use cases (staking and collateralization) will become significantly more important in the near term, while additional working capital use cases might emerge.

Governance

The last concept on how tokens can accrue value is centered around governance: the basic premise being that token ownership determines who has the power to change the rules of a platform, and under which conditions. The crypto fund Placeholder has created a whole investment thesis around governance tokens and their role in a network.

The big question is how valuable a governance token is if losers of a token vote can simply fork? That answer most likely depends on the nature of the protocol. If the underlying platform acts mostly like an open-source software library but “states” are not stored on the protocol level (e.g. 0x – the decentralized exchange protocol – acts like an open-source software library with instructions on how to build a decentralized exchange, but liquidity is built by relayers on top of 0x), then there are no network effects on the protocol level and there is little cost to fork the network (and hence little value to a governance token that would prevent such a fork).

You can find more background on the distinction between stateful protocols with network effects and protocols more akin to software libraries in this talk by Jesse Walden from a16z crypto at the recent Multicoin summit https://www.youtube.com/watch?v=Fbtz6rOKlBw

Overall, we are still early in understanding how token economies work and in which ways value can accrue to tokens. But it is exciting to see that different concepts are emerging and conviction in the strength of some concepts is building based on actual traction and usage, like in the working capital token case.

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